State Bank of India (SBI) has the financial strength to withstand tough operating conditions in the next 12 months due to its strong deposit franchise and liquidity, global rating agency S&P on Thursday said.

The very high likelihood of the government support, if needed, provides a cushion to accentuated downside risks, it said in a statement.

SBI's performance in the second quarter was broadly in line with our expectations of a rebound in performance after the lockdown, with uncertainty about the amount of incremental stressed assets emerging over the next six months, the rating agency said.

The country's largest lender SBI on Wednesday reported a 55 per cent increase in its consolidated net profit to Rs 5,245.88 crore for the second quarter ended September 30, on account of decline in bad loans.

"The bank has continued to cut the cost of deposits and boost its net interest margin, while peers have faced pressure from excess investments in lower-earning assets. Collection efficiency was excellent at 97 per cent for the quarter, excluding agriculture loans," the agency said.

Furthermore, it said, the flood of deposit funding despite interest rate cuts supports our view that SBI remains a beneficiary to a flight to quality with a highly sticky customer base.

SBI's performance is expected to be better than the industry average -- weaker than private-sector peers' but stronger than public sector peers', it added.

"We forecast SBI's credit costs to be elevated at 2.0-2.5 per cent and non-performing loans (NPLs) to increase to 8.5-9.5 per cent of customer loans from 5.9 per cent, including pro forma slippages over the next 12 months.

"In comparison, we forecast the industry average for NPLs to be 2.5-3.5 percentage points higher than SBI's and that for credit costs 0.5-1.0 percentage point above SBI's," the agency said.

It's too early to conclude the extent of loans that SBI will ultimately restructure given the ongoing pandemic, and borrowers have until December 31, 2020, to apply, S&P noted.

"In our view, weak borrowers (i.e. rated 'BB' and below) will likely continue to get weaker and be restructured or become non-performing. The bulk of SBI's borrowers are affiliated with the Indian government (e.g. public sector undertakings, government employees or government-guaranteed exposures) or strong corporate groups," it said.

Therefore, SBI's restructured loans will likely be lower than the industry average. That said, weakness in some large corporate entities may hit the bank's stressed assets, the agency added.

The government support for SBI provides a buffer to a one-notch deterioration in the bank's stand-alone creditworthiness, it said, adding that deterioration could occur from the higher-than-expected loan or provision growth, without commensurate increases in capital.

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